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Key takeaways

Annuities are the only product that can guarantee a stream of income that you can't outlive.

Your beneficiaries may be able to receive payments after you die.

Dispelling myths about annuities can open the door to many unique investment solutions.

Over the years, annuities have gotten a bad rap as being complex and expensive, the kind of investment only an insurance professional could love. Well, some are, but there is still quite a lot to love in these products—no matter what phase of life you are in—if you know what you need and you shop smart.

For example, annuities designed for accumulation let your money grow tax-deferred before and during retirement. You can also buy protection against market losses and, unique to annuities, outliving your savings. These guarantees1 come with a price, but for some investors the price is worth the peace of mind. The key is knowing what you need, the difference between various types of annuities, and how to shop wisely.

Here we debunk 5 of the most common myths and misconceptions around annuities, so you can make better decisions about your financial plan.

Myth 1: Annuities are only for retirees

Reality: Annuities can help savers too.

While immediate annuities are designed to turn savings into an income stream right away—typically, for retirees, deferred annuities (variable or fixed) are a tax-deferred savings vehicle used by investors to save more for retirement. With a deferred annuity, you can grow your investment tax-deferred, then turn it into an income stream at some point in the future. If you have maxed out on contributions to your 401(k), 403(b), other employer-sponsored retirement savings plan, or an IRA, deferred annuities can offer an additional tax-deferred vehicle to help you build wealth.2

You can choose from 2 types of deferred annuities:

Deferred variable annuities have investment options that are very similar to mutual funds. You can typically make unlimited3 contributions and control how you allocate among investment options. To benefit most from a deferred variable annuity’s tax-deferred savings opportunity, use a low-cost annuity—some products are available for fewer than 50 basis points (0.50%) of your investment annually.4

Deferred fixed annuities include single premium deferred annuities (SPDAs), which are similar to a certificate of deposit (CD). You are guaranteed an interest rate for a specific period of time, typically 1 to 10 years. These fixed annuities are insured by the issuing insurance company rather than by the FDIC.

For both types, investors need to be comfortable not taking withdrawals before age 59½.2

"It's important with any annuity product to make sure you're investing with a highly rated company," says Tim Gannon, vice president at Fidelity Investments Life Insurance Company. "A good way to tell is by checking with a rating agency like Standard & Poor's or Moody's. These are independent rating agencies that conduct regular reviews of an insurer’s financial strength and ability to pay its contractual obligations."

Myth 2: Annuities cost too much

Reality: Many annuities are low cost. Others offer potentially valuable additional features at higher costs, which you should consider only if you need to address a specific risk.

When it comes to choosing an annuity, first consider what you need the annuity to do: build savings or create income. Be sure to compare the cost against the value of each additional guarantee, feature, and benefit—and only pay for what you need and align it with when you need it to avoid paying surrender charges.

If you need to maximize your tax-deferred savings, choose a low-cost deferred variable annuity. According to Morningstar Annuity Research Center, variable annuity annual fees range widely, from 0.10% to 2.25%, with an industry average of 1.16%.4,5 Of course, you will pay more if you need to address a specific risk with a guarantee, such as a guaranteed living benefit, which provides income or asset protection from down markets.

Generally, variable annuities charge explicit fees, while fixed annuities tend to embed their costs in the interest rate or income payout amount. Focus on finding a competitive payout rate and an insurance company that is reputable and financially sound.

Myth 3: There is no point in buying an annuity for income before retirement

Reality: As you approach retirement, certain annuities can help protect your future income from market volatility, and some annuities can help protect against inflation.

If your retirement is 10 years away or less, you probably worry that a drop in the market could erode the savings you've worked hard to accumulate. There are 2 types of annuities available that may grant you some peace of mind: a deferred income annuity6 (DIA), and a fixed deferred annuity with a guaranteed lifetime withdrawal benefit (GLWB) rider.

When you purchase a DIA, you select the future date on which your payments will begin, providing guaranteed income for the rest of your life no matter what the market does. Because they are designed to create future income, DIAs provide the greatest advantage if you don’t need to access the money until you reach your selected income start date.

You can lock in a future cash flow that starts on the future date you selected when you purchased the annuity. At age 58, to create a $1,000 monthly lifetime income payment beginning at age 70, you would invest approximately $108,000 today. If you waited until you were age 68 to purchase an annuity, you would need to invest slightly more than $170,0007 for the same level of income.

These types of annuities also enable you to plan for inflation by offering a cost-of-living adjustment, known as a COLA. When you purchase the contract and for an additional cost, you can select to have your income increase annually by a percentage, typically 1%–5%. This COLA adjustment takes effect after you begin receiving income, but not during the deferral period.

Another alternative is a fixed deferred annuity with a GLWB, which allows some flexibility with your investment but may offer a slightly lower guaranteed payment. When you purchase this type of annuity, you will lock in predictable, guaranteed lifetime income that begins on a date you select. Your lifetime withdrawal benefit amount will be tied to your age when you begin withdrawing and deferral period—generally, the longer you wait to take your lifetime withdrawal benefit amount, the higher it will be.8

Work closely with your financial consultant as you build a comprehensive retirement income plan to determine whether these annuities are appropriate for your personal situation.

Myth 4: I can easily create lifetime income from my retirement accounts

Reality: Besides Social Security and pensions, only annuities guarantee a stream of income that you can't outlive.

Because you can't predict the markets, you can't be sure that you won't outlive your investment portfolio. Indeed, our research suggests that to have a high level of confidence that that won't happen—even if the markets turn bearish just when you retire—you may consider limiting your withdrawals to 4% a year, adjusted annually for inflation. With an annuity, however, you enter into a contract with an insurance company that will pay you a certain amount for the rest of your life, giving you the peace of mind that comes from knowing that this specific income stream is guaranteed to never run out during your lifetime.

For example, a single premium immediate annuity (SPIA) or a DIA can play that important role in your retirement income plan. A key benefit of SPIAs and DIAs is that they ease money management as you enter your 80s or 90s. That’s because when you invest a lump sum with an insurer today, the insurance company guarantees you will receive a monthly income payment for the rest of your life. No maintenance is required.

"What people may not realize is, once you have your essential expenses covered by guaranteed lifetime income, you gain peace of mind and the freedom to pursue the things you love in life," observes Tom Ewanich, vice president and actuary at Fidelity Investments Life Insurance Company. "Additionally, you may invest your remaining assets for growth, rather than worrying about how to preserve and stretch your portfolio for the rest of your life." Just be aware that once you purchase an SPIA or a DIA, you generally lose access to these assets after the "free look" period—a brief period of time immediately after purchasing a contract when you can cancel the contract and have your money refunded.

Myth 5: The insurance company gets my money when I die

Reality: Your beneficiaries can receive payments after you die.

Most deferred annuities are designed to pass the account value on to your heirs. Income annuities offer options that can also provide for your beneficiaries in some situations. With income annuities, as long as you don't select the largest payout option of "life only," you can arrange to have income payments continue on to your beneficiaries if you were to pass away prematurely. Of course, this adds to the cost, but it could be worth the extra price, depending on your situation. Be sure to work with your financial consultant and discuss the beneficiary options available to you for each type of annuity you're considering.

Bottom line

Annuities can offer flexibility both in how you save for and receive money in retirement. It all comes down to understanding that there are several different types of annuity products, each of which is designed to address a specific need or life stage. And remember, the best way to explore how they might complement your investment strategy is to work with your trusted financial consultant.

Next steps to consider

These annuities can offer growth, but it's important to know what you're buying.

Before investing, consider the investment objectives, risks, charges, and expenses of the annuity and its investment options. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.

Investing in a variable annuity involves risk of loss - investment returns and contract value are not guaranteed and will fluctuate.

1.

Guarantees are subject to the claims-paying ability of the issuing insurance company.

2. Withdrawals of taxable amounts from an annuity are subject to ordinary income tax and, if taken prior to age 59½, may be subject to a 10% IRS penalty.

3. The issuing insurance company reserves the right to limit contributions.

4. Underlying fund fees apply and surrender charges may also apply.

5. Data as of 12/31/2017 for 356 nongroup open variable annuity contracts.

6. Deferred income annuity contracts are irrevocable, have no cash surrender value, and no withdrawals are permitted prior to income start date.

7. Estimates provided through the Guaranteed Income Estimator as of June 27, 2018 for Life with Cash Refund Option selected for the state of Massachusetts. Purchase at male age 58; assumes income begins in 2029 at age 70. Purchase at male age 68; assumes income begins in 2019 at age 70. Actual SPIA rates in 10 years will be different.

8. Withdrawal rates are banded and increase at certain ages. They stop increasing at age 80. The annual increase rate is applicable for a maximum of 10 years.

Fidelity insurance products are issued by Fidelity Investments Life Insurance Company (FILI), 100 Salem Street, Smithfield, RI 02917, and, in New York, by Empire Fidelity Investments Life Insurance Company®, New York, N.Y. FILI is licensed in all states except New York. Other insurance products available at Fidelity are issued by third-party insurance companies, which are not affiliated with any Fidelity Investments company. A contract's financial guarantees are subject to the claims-paying ability of the issuing insurance company.

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